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Sunday, February 24, 2008

The Sensex ended the week on a weak note after exhibiting range-bound movement with a negative bias.

The bulls could hardly bank on the preceding’s week’s profits as the Sensex gave up its gains after touching a high of 18,314, up 199 points from the previous week’s close.

The index, thereafter, drifted to a low of 17,295, down 1,019 points from the week’s high. It finally ended at the lower end of the week’s range at 17,349, down 766 points (4.2 per cent).

Among the index stocks, HDFC (down almost 12 per cent), SBI and ICICI Bank (lower by 8 per cent each) and Reliance (6 per cent weak) were the major draggers. On the other hand, Cipla was the major gainer (up nearly 9 per cent). Hindalco and Bajaj Auto also settled with smart gains.

The trend this week will depend on the derivatives expiry and the budget. While the market sentiment remains subdued, the Sensex has a near-term support at 16,950.

The index is likely to move in a range of 16,200 and 19,000 in the short term until a breakout happens in either direction. It is likely to find support around 16,960-16,840-16,71 and may encounter resistance around 17,740-17,850-17,980 this week.

The Nifty moved in a range of 276 points, from a high of 5,368 and a low of 5,093, before finishing with a loss of 192 points (3.6 per cent) at 5,111.

The index may face resistance around 5,215-5,250-5,280, while support on the downside is likely to be around 5,005-4,970-4,940.

The Nifty will continue to move in a broad range of 4,800 to 5,700, before a fresh trend emerges. The index is below its short-term and medium-term daily moving averages (DMA), which are 5,192 and 5,617 respectively. It is also close to its 200-day DMA of 5,026. One may therefore expect some support around these levels.

Anil Ambani-promoted Reliance Power shareholders, who were battered on the listing day of the scrip, effectively reduced their losses by as much as 40% over the IPO price after the company announced the bonus issue on Sunday.

The board of directors at its meeting considered and approved a bonus issue, excluding promoters, wherein three shares would be allotted for every five held by the non-promoter shareholders.

"This move would effectively reduce the cost of Reliance Power shares from the IPO price," Reliance Power Chairman Anil Ambani said. Retail investors were allotted the shares at Rs 430 while institutional investors got it at Rs 450.

ursuant to this bonus issue, retail shareholders would receive the shares at Rs 269 each while for institutional shareholders, it would be Rs 281 per share.

"Compared to the IPO price, for the retail investors it represents a reduction of 40 per cent and for institutional 37 per cent," Ambani added.

The bonus issue follows the dismal opening of Reliance Power at the stock exchanges. The scrip, after listing at Rs 547.8, slid within a minute and closed at Rs 372.5, a level much below the issue price.

Reliance Power scrip closed at Rs 416.85, down 1.21 per cent on Friday at the BSE.

On February 20, the company said it had asked its shareholders to make balance payment by February 26 on shares allotted to them in the IPO to be eligible for bonus shares.

Reliance Power's IPO had offered a discount to retail investors, and an option of staggered payment to all segments.

The record date for the bonus shares would be fixed in consultation with stock exchanges and in compliance with provisions of the listing agreement, the firm added.

Investment with a two-three year perspective can be considered in the stock of Aban Offshore, a leading provider of offshore drilling services. Spurt in global exploration activities on the back of a rising oil price scenario points to good prospects for Aban.

Given the large fleet size and presence in global markets through its foreign subsidiaries, Aban could emerge as one of the leading beneficiaries of this demand uptrend.

Aban’s well-timed fleet expansion moves are backed by good operating efficiency and re-pricing of old contracts at higher rates. At the current market price of Rs 3,887, the stock trades at 11 times its likely FY-09 per share earnings.

This appears reasonable considering Aban’s historical earnings growth and the ongoing cyclical uptrend in the offshore drilling industry. Investors can utilise the recent correction in the stock market to accumulate the stock.Expansion in fleet size

Aban’s strategy of expanding its fleet size has helped given the rising demand for rigs on the back of a relative stagnation in availability. After the acquisition of Norway-based Sinvest ASA, Aban’s fleet size has increased to over twenty offshore assets, which includes 15 jack-up offshore drilling rigs, two drill ships, one floating production platform and a jack-up and drill ship each on bareboat charter. This fleet size is huge vis-À-vis other domestic players and compares well with some of the bigger global players as well.

Equipped with such a large rig bank, we expect Aban to enjoy a fast track growth in revenues, given the tight supply of rigs worldwide.

This apart, the proposed addition of a few more rigs to the company’s fleet in a couple of years may also lower the average age of its fleet considerably. This is likely to improve the marketability of Aban’s rigs, even as day rates might begin to taper-off by 2010. Further, Aban also stands to benefit by way of expansion in margins given the relatively lower refurbishment cost of new rigs.Strengthening day rates

With a dearth in availability of oil rigs, day rates over the past couple of years have soared significantly. In this context, the re-pricing of most of the existing contracts of Aban Offshore (the standalone entity) at attractive prices lends confidence on the demand scenario. It also provides earnings visibility for Aban over the medium-term since most of these contracts have been committed for a medium-term horizon.

The most recent renewal of its three-year contract for Frontier Ice with ONGC at a day rate of about Rs 62 lakh (a significant premium to market expectations) reiterates the strong demand prospects.

Notably, this contract also (previously Aban II and Aban VI) has been billed in non-USD currency. This might offer some respite to Aban’s earnings from any likely depreciation in the US currency.Financials

On a standalone basis, the company clocked an earnings growth of over 130 per cent for the quarter ended December 2007. This was achieved on the back of a 34 per cent increase in revenues, thanks to the re-pricing of two of its assets during the quarter.

Operating profit margin was marginally lower at about 53.08 per cent. The company, however, has a high gearing, given the aggressive capex incurred for the construction of new assets and the funding of its Sinvest acquisition. While this could weigh on Aban’s earnings over the medium-term, it may begin to ease-off once the new assets become operational. Till such time, Aban’s cash flows may help it service its debt efficiently.Near-term triggers

The company is expected to announce the contract for its newly built jack-up Aban VIII in the next couple of months. This, if struck at higher than expected rates, may offer a short-term upside trigger.

Besides, the proposed listing of its Singapore subsidiary, aimed at refinancing its existing debt structure, may also provide an earnings upside.

While the company expects to retire a chunk of its debt through the potential listing, a lot might hinge on the revival of the IPO market and the perceived valuation of the subsidiary. That apart, a fall in oil prices and excess supply of oil rigs, resulting in a lower day rates, may pose a downside risk to our recommendation.

The Ultra Tech Cement stock seems a reasonable investment option for investors with a medium-term investment horizon. The company has ambitious plans for capacity addition that could support volume growth, cost-saving measures that may improve margins and solid financials.

The company’s 4.9-million-tonne capacity in Andhra Pradesh will be fully operational by this March. Ultra Tech has also planned an additional Rs 3,300-crore capex on de-bottlenecking exercises and setting up captive power plants that would further improve operating margins. At the current market price of Rs 889, the stock trades at 13 times its FY-08 earnings which, compared to peers — ACC and Ambuja Cements — is at a discount. Investors with a one-two year perspective can consider exposure in the stock.

The company has reported a 19.5 per cent growth in net sales in the nine months between April and December 2007, with a 36 per cent increase in operating profits and a 3.80 percentage point expansion in margin. The southern and western regions, the main target markets for the company may witness stronger demand growth for cement in the year ahead on account of an expected increase in demand from the infrastructure sector.Business Overview

Earlier the cement division of L&T, Ultra Tech Cement demerged from it in 2004 and was acquired by the Aditya Birla group with a 30 per cent stake taken by Grasim Industries. The company is a major player in the West with plants located in West Bengal, Maharashtra and Gujarat and one plant each in Tamil Nadu and Andhra Pradesh.

Ultra Tech has a capacity of 17 million tonnes to which it is adding 4.9-million tonne by commissioning a unit in March this year. With this, the company’s total capacity would go up to 21.9 million tonnes by the end of this quarter. The said 4.9-million tonne would be an addition to its Tadipatri unit in Andhra Pradesh, strengthening the company’s presence in the South.

The southern region has seen relatively firm trends in cement prices due to strong demand growth. The market appears capable of absorbing the incremental supply generated by the company; demand in this region recorded a 12.6 per cent increase between April and December 2007. The outlook for FY-09 also looks quite promising with several government-funded infrastructure projects taking off in Tamil Nadu and Andhra Pradesh.

The company has also announced a Rs 3,300-crore capex plan for de-bottlenecking exercises and to build captive power plants over the next three years. A new captive power plant at Gujarat is set to be operational by end-March. Of the total capex of Rs 3,300 crore, Rs 1,700 crore may be funded by debt and Rs 1,600 crore through internal accruals. Strong volume growth may, thus, make up at least partially for any moderation in cement prices expected on account of fresh capacities going onstream over the next year.Financials

Ultra Tech Cement has reported an impressive performance in the recent December quarter, helped by higher realisation and improved operational efficiency. While net sales inched up by 10 per cent, operating margins too expanded strongly by 3.86 percentage points.

Volumes for the quarter ending December 2007 registered a 6 per cent growth from 3.21 million tonnes in Q3FY-07 to 3.40 million tonnes. Net sales for the quarter grew 10 per cent, from Rs 1,260 crore to Rs 1,382 crore. The company’s plants are now running at 102 per cent utilisation levels.

Despite a 11.9 per cent increase in fuel cost due to rising coal prices, the company was able to record an expansion in operating margin primarily because of improved production efficiency.

The operating profit mounted to Rs 488.62 crore, up 23 per cent from Rs 396.9 crore in the corresponding previous quarter.Risks

The huge capacity additions that would be coming on stream towards the end of FY-09 could bring down the utilisation rates across players. Lower-than-expected demand or further policy measures to curtail cement prices could pose risk to realisations and, thus, earnings

Investors with a one-two year perspective can consider buying the shares of 3i Infotech in the light of its good business prospects and reasonable valuations.

At Rs 126, the stock trades at 13 times its current year earnings and 10 times its estimated FY-09 earnings. This is a discount to MindTree Consulting and Polaris Software, but a slight premium to Zylog Systems and Hexaware Technologies, all of which have substantial banking and financial services industry (BFSI) exposure. But a niche BFSI focus and superior earnings before tax, depreciation and amortisation (EBITDA) margin (25 per cent) make the stock an attractive ‘buy’ among Tier-2 IT players.

3i Infotech has a robust business model because of a high-margin product-driven business, a healthy geographic spread that includes a significant domestic focus and selective acquisitions to tap new clientele.

A lower dependence on the US and a presence in the critical aspects of the BFSI industry will lead to 3i Infotech being minimally affected, certainly less than its Tier-2 peers, due to the sub-prime crisis.Business drivers

Products expand margins: 3i Infotech has a near-equal products-services mix in its IT offerings. Product software generates higher margins than traditional volume-based services such as application development and maintenance.

The company also offers products and services spanning the entire gamut of IT requirements for financial services companies to cater to banks, insurance companies, mutual funds and capital markets. It also has offerings in the enterprise resource-planning segment.

This 50-50 mix (between products and services) and end-to-end offering for the BFSI segment gives 3i Infotech an edge over other Tier-2 IT services companies in terms of service offerings and margin profile.

Increasing presence in domestic e-governance and telecom: In domestic markets, 3i Infotech has been able to increase its presence in Government-initiated projects, going by the large-scale deals that it has managed to win recently. The company has won a Haryana Government project for the establishment of e-Disha Ekal Seva Kendra Project.

As a part of the project, the company will set up over 322 citizen service centres. Single-window delivery of services such as issue of land record certificates and ration cards, pension schemes, public grievance redress and payment of telephone and electricity bills, among other services, are envisaged to be provided. 3i Infotech will provide the IT infrastructure and a Web interface to enable these services.

This deal follows a similar one from the Goa Government that entails the setting up of 208 citizen service centres by the company.

The nature and scale of these projects mean that 3i Infotech can be expected to generate a stable revenue stream over a multi-year period. Considering that government spend on providing IT and IT-enabled services is on the rise, scaling up of operations in these service centres can provide the company with additional revenues.

Also, the company has won deals in the telecom space in India. These include provision of IT and BPO services. Although this segment is a small contributor to revenues, a presence in the fastest growing mobile services market in the world makes it well-placed to scale up operations and become a key revenue driver.

Geographic spread: The company has a wide geographic spread in its revenue mix. It generates as much as 56 per cent of its revenues from India, Asia-Pacific and West Asia. The US contributes to about 25 per cent of its revenues, which is significantly lower than other peers in this space.

The company claims that its exposure to banking clientele in the US accounts for only 5 per cent of its global revenues and, even here, its presence is in the cheque and payment processing areas, which are essential operations for banks.

Overall, this spread may help 3i Infotech to be minimally impacted by the appreciation of the rupee against the dollar. West Asia and the Asia Pacific regions are also fast growing ones in terms of IT infrastructure spending and offer opportunities that 3i Infotech may be well-placed to tap.

The deal is valued at $25.25 million and 3i has indicated that the acquisition would be immediately EPS-accretive.

J&B is a product software company for functions such as processing and managing automated electronic payment transactions of banks, insurance companies, mutual fund providers, credit-card processors and even telecom companies.

This acquisition creates several advantages for 3i Infotech. First, it would enable the company to expand its North American footprint by tapping J&B’s clientele.

Second, J&B’s product software would be a significant addition to 3i Infotech’s product portfolio in the BFSI segment.

Third, with J&B’s offering, which is mainly on open architecture platforms, 3i would be better placed to tap other high-potential markets such as Asia-Pacific.

3i had earlier entered the European markets through the acquisition of Rhyme Systems in late 2006. This appears to have worked for the company as Europe now contributes significantly to 3i Infotech’s revenues.Risks

Though the company’s direct exposure to the US loan market is limited, vulnerability to the sub-prime crisis could arise from an indirect exposure, what with investment banking players across the US and Europe announcing huge write-offs.

Operating in the Asian region, especially India, could lead to deal sizes and margins being lower compared to other geographies such as the US. An increasing governmental client base could extend the receivables cycle.

Investors seeking a defensive play in the run-up to the Budget can consider putting their money into the NTPC stock. The stock is now trading at more reasonable valuations compared to the peak of the market euphoria over power stocks barely a month ago. At the current market price of Rs 197, the stock trades at 20 times the projected earnings for 2007-08; down from over 26 at its height.

While the pace of appreciation from current levels could be slower compared to the recent past, the downside appears minimal. There’s likely to be little in the Budget to affect the stock adversely; if anything, it could make things brighter for the company through a sharper focus on the power sector accompanied by higher allocations.

NTPC plans to scale up its present capacity of around 27,000 MW to over 50,000 MW in the next five years. The company will also be commissioning by early-2009 its first hydro power plant at Kol Dam in Himachal Pradesh.

NTPC is an efficient generator when it comes to coal-based stations where its plant load factor is around 93 per cent, but the story is different when it comes to gas-based stations.

Here, the company is plagued by domestic gas shortage and the choice is to either idle the plants or run them on costly imported liquefied natural gas.

The high operating efficiencies translate into a healthy financial position for NTPC. Profit after tax fell 15 per cent in the third quarter ended December 2007 largely due to a higher provision for tax and increased staff costs.

Healthy profitability

Profitability continues to be healthy; the company has maintained a return on net worth in excess of 14 per cent in the last three years.

At an average cost of Rs 1.77 per unit, NTPC’s power is very competitive but the cost could increase as newer capacities kick in over the next year.

The company has also begun to address the equipment shortage issue by forging joint ventures with BHEL and Bharat Forge to produce power generation and other equipment.

In the medium to long term, these joint ventures will ensure that NTPC’s expansion plans do not suffer for want of equipment.

"In a bull market your game is to buy and hold until you believe that the bull market is near its end."

"My dear boy," said old Partridge, in great distress "my dear boy, if I sold that stock now I'd lose my position; and then where would I be?"

"It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!"

"Men who can both be right and sit tight are uncommon."

"The market does not beat them. They beat themselves, because though they have brains they cannot sit tight."

"He really meant to tell them that the big money was not in the individual fluctuations but in the main movements that is, not in reading the tape but in sizing up the entire market and its trend."

"Obviously the thing to do was to be bullish in a bull market and bearish in a bear market."

"When your security is acting right, you can safely add to your line from then forward!"

"When I buy stocks for a rise I like to pay top prices and when I sell I must sell low or not at all."

"When this happens I sell the stock short that is, technically. In other words, I sell more stock than I actually hold."

"Experience has proved to me that real money made in speculating has been in commitments in a stock or commodity showing a profit right from the start."

"It is literally true that millions come easier to a trader after he knows how to trade, than hundreds did in the days of his ignorance."

"If my stock does not act as I anticipated, I immediately determine that the time is not yet ripe – so I close out my commitment."

"The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you can familiarize yourself with the actions of the past, you will be able to anticipate and act correctly and profitably upon forthcoming movements."

"From my point of view, the investors are the big gamblers. They make a bet, stay with it, and if all goes wrong, they lose it all."

"A great many smashes by brilliant men can be traced directly to the swelled head — an expensive disease everywhere to everybody, but particularly in Wall Street to a speculator."

"There is only one side to the stock market; and it is not the bull side or the bear side, but the right side"

Reminiscences of a Stock Operator by Edwin Lefèvre, the source work from which most of these quotations are taken. This is a newly edited and updated version for ease of online reading, with fully restored typography conventions and author's phrasing to accurately reflect intended meaning of the original published work. Hyperlinks to external references have been introduced to help clarify unfamiliar terminology and offer background context about key personalities and events mentioned in the text.

Even as legal minds continue to debate the technical issues surrounding Reliance Power’s proposed bonus issue, investors are eagerly awaiting the bonus ratio expected to be announced after the board meet on Sunday.

The Reliance Power board is scheduled to meet on Sunday to consider issue of bonus shares and/or other measures aimed at reducing the cost of acquisition for minority shareholders, who have suffered losses due to the poor performance of the stock since listing.

Since the promoters will not be issued any bonus shares, their stake will automatically be diluted from the current 90%, once the board clears the proposal. Shares of R-Power closed at Rs 417 on BSE, down 1.2% on Friday.

For instance, if the market price on the record date is Rs 400 a share, then the minority shareholders’ cost of acquisition will come down by Rs 42-150 per share, depending on whether the company allow one bonus share for every five held, or one bonus share for every one held. There would have been no gains to any shareholders if the promoters would also have subscribed to the bonus issue.

The calculation is based on the post-bonus dilution in equity capital of R-Power and a pro-rata adjustment in its share price. If the board decides to issue one bonus share for every five shares held by the non-promoters on the record-date, then dilution works out to 2% and there would be a similar decline in the stock price. In comparison, the investor’s acquisition cost will fall by 20%.

In case of a 1:1 bonus, the dilution works to be 10% and the R-Power market price is expected to be adjusted by the similar price while the investor’s acquisition cost will come down by half.

If price falls below Rs 400, the gains will heavily depend on the bonus ratio. For example, if the price on the record date falls to Rs 300 per share, the investors stand to profit only if the company decides to issue at least one share for every two shares held. In the worst case scenario, if the share prices of R-Power plunge to Rs 250 by the record date, then the investors will not make money even if the bonus ratio is a liberal 1:1.